Investment demand theory , Managerial Economics

In the national income analysis, investment refers to the value of than part of the aggregate output for any given time period which takes the form of construction of new structures, installation of new capital equipment and positive change in business inventories in the economy. The value of this output , apart from changes in inventories, is measured by the amount of total expenditure incurred on these items, defined in this manner, investment can be either gross or net, from the gross investment , the replacement investment must be deducted in order to obtain the net investment in the economy . Investment gross or net includes the purchase of business structures such as manufacturing plants, warehouses and stores, and producers durables like lathes, milling machines, typewriters calculation computers and trucks. Investment also includes expenditure incurred on the construction of all residential structures including both owner occupied houses and rental housing.

Any attempt to explain the aggregate investment spending in the economy during any given time period is faced with the difficulty that different types of investment outlays are influenced by different factors. Consequently, no one single theory can adequately explain all the forms of investment outlay. For instance, investment made in the owner occupied residential construction is not significantly affected by profit motives while the investment made in the industrial structures, rental housing and business inventories is primarily affected by the profit motive.

Investment is a flow concept while capital is a stock concept. By capital we mean here the accumulated stock of plant and equipment held by the business sector . if the aggregate investment during any given time period for the economy is just equal to the replacement investment--- investment needed to maintain the economy existing total capital stock in tact by providing for the wear and tear of the plant and equipment during the process of production and for the accidental damage to machinery the net investment addition to economy total capital stock (ΔK) in the economy for that period will be zero. If any given time period to gross investment exceeds the replacement investment (investment required to provide for the capital consumed in the process of production) the net investment will be positive and economy total capital stock will increase by the extent of net investment i.e.,Δ Kt= Inet . on the contrary if gross investment in the economy is less than the capital replacement requirement, net investment will be negative . consequently the economy capital stock will decrease and unless the capital output ratio (K/O) falls economy production capacity will also decrease. it therefore , follows as first lesson in economic growth that if the economy has to grow over time its capital stock must also grow. In fact accelerate economic growth requires that along with the growth of economy capital stock the capital output ratio must also fall by constantly adopting the progressively capital saving techniques of production.

Net investment represents addition to economy total capital stock which ceteris paribus, means an increase in the economy total productive capacity. This is so because larger physical capital stock used with the existing quantities of other inputs labour technology and natural resources would result in the larger total physical output although the additional output due to the employment of additional capital units would diminish as the capital stock continues to increase.

In real world, however other things do not remain the same as economy total capital stock grows over time. as capital stock in the economy grows over time labour force also grows both quantitatively and quantitatively ( in the form of increased labour productivity) and production techniques improve. Whether we assume a given state of arts or technological improvements taking place in the economy and creating the demand for investment necessitated by modernisation of firms plants and equipment for the economy as a whole , net investment increase the economy aggregate productive capacity.

Posted Date: 12/1/2012 4:46:21 AM | Location : United States

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